Rising Income Inequality Has Been Exaggerated: 2X

From the paper "The Welfare Implications of Rising Price Dispersion" by Chicago economists Christian Broda and John Romalis:

"This paper uncovers a new fact: non-durable inflation for poorer households has been substantially lower than for richer households.

Using scanner data on household consumption of non-durable goods between 1994 and 2005, we document that the relative prices of low-quality products that are consumed disproportionately by low-income households were falling over this period. This implies that non-durable inflation for the 10th percentile of the income distribution has only been 4.3 percent between 1994 and 2005 (0.4 percent per annum), while the non-durable inflation for the 90th percentile has been 11.9 percent (1.0 percent annually), and 13.4 percent (1.2 percent annually) for the richest 5 percent of households in the sample (see chart above)."

The authors conclude that:

"A large literature has focused on the rising inequality observed in official statistics, but have mostly abstracted from the fact that these official measures are based on a single price index for a representative consumer. This assumption is not crucial in a world with a stationary relative price distribution or where an identical basket of goods is consumed by different income groups. However, using household data on non-durable consumption, we document that the relative prices of low-quality products that are consumed disproportionately by low-income consumers have been falling over this period.

This fact implies that measured against the prices of products that poorer consumers actually buy, their “real” incomes have been rising steadily. As a consequence, we find that around half of the increase in conventional inequality measures during 1994–2005 is the result of using the same price index for non-durable goods across different income groups. Moreover, given that the increase in price dispersion does not seem to be specific to our sample or time period, the overstatement in the increases in inequality from official measures can be even more significant, changing our view of how progress has been distributed in recent decades substantially."

MP: In other words, by using a single price index to adjust incomes for inflation, the findings of rising income inequality have been exaggerated. Because non-durable inflation (food, clothing, fuel, cosmetics, paper, etc.) for consumers in the 10th percentile was 7.6 percent lower than inflation for the 90th percentile between 1994-2005, and 9.2% lower than for the 95th percentile, about half of the increase in income inequality during this period was the result of using the same price index for all income groups.